How to Adjust a Bull Call Spread Strategy?

July 12, 2024 (Investorideas.com Newswire) Options trading strategies may seem rigid at first glance. Whether it is a simple vertical spread or a multi-legged strategy, the rules of execution may appear strict and inflexible. However, not many traders are aware of the hidden potential of options strategy adjustments.

By adding new positions, changing the structure of a trade or rolling your positions, you can capitalise on price movements even if the market moves in an unexpected manner. This is why options strategy adjustments give you a great deal of flexibility and make it possible to adapt to changing market conditions. Whether the market moves against your position or surges beyond your initial expectations, understanding how to adjust your strategy can be crucial for managing risk and maximising potential returns.

To better understand how options strategy adjustments work and what traders should be mindful of, let us focus on one strategy - the bull call spread. We'll explore why adjustments might be necessary in this strategy, the capital requirements involved and the potential outcomes of these modifications. Below is the entire explanation of the strategy, with practical examples using tools provided by Samco, the best options trading platform that has a multitude of features and can help you easily create options strategy adjustments.

The Bull Call Spread: An Overview

The bull call spread is a strategy that can be useful if you are moderately bullish on a stock or underlying asset. It is a vertical spread - meaning that it involves a sale and a purchase of the same type of options contracts with the same expiry but different strike prices. The spread or difference lies in the prices of the options chosen.

To set up this trade, here is what you need to do.

• Buy an at-the-money (ATM) call option that has a strike price equal to or near the asset price
• Sell an out-of-the-money (OTM) call option that has a higher strike price

Since the long call is ATM and the short call is OTM, you will end up paying a higher premium for the call you buy than the call you sell. This means the bull call spread carries an upfront net debit.

If the price of the underlying asset at expiry is between the breakeven point and the higher strike price, the trade will be profitable. The breakeven point is calculated as the lower strike price plus the net cost of the spread.

Setting Up the Bull Call Spread: An Example

Before we understand how an options strategy adjustment works in the case of a bull call spread, we need to discuss how the trade is set up with hypothetical numbers. Consider a company that is currently trading at Rs. 1,000 per share, with the lot size of its options being 100 shares.

To set up a bull call spread using this stock's options, you must:

• Trade 1: Buy 1 lot of a Rs. 1,000 call option (you pay Rs. 50 per share or Rs. 5,000 for the lot)
• Trade 2: Sell 1 lot of a Rs. 1,100 call option (you receive Rs. 20 per share or Rs. 2,000 for the lot)

The net cost of the spread in this case will be Rs. 30 per share or Rs. 3,000 per lot. In addition to this, you will also have to pay the margin money required for the short position. The exact amount can vary based on the stock's volatility and other factors, but ensure that you account for the margin in your actual trade plan.

You can use the SPAN margin calculator on the Samco trading platform for more clarity on the margin required for your trade. This trade planning tool is available free of cost for all traders online.

Possible Outcomes and Adjustments Required

One of the following scenarios may occur:

1. The price of the stock may rise moderately as expected
2. The stock price may unexpectedly fall
3. The stock price may rise much more steeply than expected

Here, the first scenario is favourable while the other two are not. Let us decode each scenario further.

• Scenario 1: The Stock Price Rises to Rs. 1,080

This falls within the profitable range. So, in trade 1, the long call is an in-the-money trade with an intrinsic value of Rs. 80 per share (i.e. Rs. 1,080 - Rs. 1,000). This means you earn Rs. 8,000 from this trade (i.e. Rs. 80 x 100 shares). In trade 2, the short call expires worthless.

The total gains from this position amount to Rs. 5,000 (i.e. Rs. 8,000 from the long call minus Rs. 3,000, which is the upfront cost of setting up the trade).

• Scenario 2: The Stock Price Falls to Rs. 900

In this case, the price movement is bearish, making both the options expire worthless. So, your trade is in a loss amounting to the upfront cost of Rs. 3,000. In this case, you need to reassess your market view and check if it has changed.

If you now expect the bearish movement to continue and think the stock price will fall further by expiry, you can execute an options strategy adjustment to mitigate the loss you currently face. Given your new bearish outlook, it is better to adopt strategies that benefit from a declining market.

Buying a call option (even at a lower strike) would not align with a bearish outlook, as call options gain value when the stock price rises. Instead, here are two effective alternatives:

• Alternative 1: Sell a Call Option

You could sell a call option with a lower strike price. This strategy could generate premium income, which can help offset the initial loss of Rs. 3,000. For instance, say you sell a Rs. 900 call option and receive Rs. 40 per share or Rs. 4,000 for the lot). This helps set off the earlier loss.

• Alternative 2: Buy a Put Option

You could also buy a put option with a strike price above the expected fall level, say at Rs. 900 or Rs. 950. This will allow you to profit from the decline in the stock price.

That said, as with any new position, you will have to account for the additional capital required to buy a put option or the additional margin required if you sell a call option.

• Scenario 3: The Stock Price Rises to Rs. 1,200

In this case, the price movement is bullish, as expected. However, instead of a moderate price rise, you have a steep price increase that makes both the options in-the-money contracts.

• In trade 1, the long call has an intrinsic value of Rs. 200 per share (i.e. Rs. 1,200 - Rs. 1,000). This means you earn Rs. 20,000 from this trade (i.e. Rs. 200 x 100 shares).
• In trade 2, the short call has an intrinsic value of Rs. 100 per share (i.e. Rs. 1,100 - Rs. 1,000). This means you have an obligation of Rs. 10,000 for the lot in this trade (i.e. Rs. 100 x 100 shares).
  

The total gain from this position would be Rs. 7,000 (i.e. Rs. 20,000 from the long call minus Rs. 10,000 from the short call, minus the initial Rs. 3,000 cost of the spread). In this case, you can close the bull call spread and collect this profit.

However, if your market outlook has significantly changed and you now want to prepare for an even further upside beyond Rs. 1,200, you can make use of an options strategy adjustment, as explained below.

The options strategy adjustment in this case will require you to open a new spread with higher strikes and a later expiry, as represented by the following potential trades:

• Trade 1: Buy 1 lot of a Rs. 1,200 call option (you pay Rs. 80 per share or Rs. 8,000 for the lot)
• Trade 2: Sell 1 lot of a Rs. 1,300 call option (you receive Rs. 50 per share or Rs. 5,000 for the lot)

To implement this options strategy adjustment, you need additional capital to execute the trade and meet the margin requirements for the new positions, as determined by the stock exchange.

Options Strategy Adjustments Made Easier on the Samco Trading App

The bottom line is that options strategy adjustments can help you turn a potentially loss-making trade into a profitable position. However, you must be mindful of the fact that adjustments often require additional capital, either for new positions or increased margin requirements.

So, ensure you have sufficient funds available and consider how tying up more capital in one position might affect your overall portfolio management.

To make options strategy adjustments easier, consider the Samco trading platform, which offers a wide range of tools to make F&O traders quick and easy. Samco's options strategy builder, Options B.R.O, can help you pinpoint the ideal trading plan for your changing market views. What's more, you can also make use of the SPAN margin calculator and other free tools available on the Samco trading platform to finetune your traders easily.

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